Can I do a 1031 if my Property is Being Purchased Under Eminent Domain?

Sometimes we have clients call and say that their property is being purchased as part of an eminent domain or involuntary taking and they wonder if a 1031 exchange is an option in this scenario.

Section 1033

There is another code section that maybe applicable in these situations - code section 1033 of the Internal Revenue Code. Under that provision you can have a longer period of time (sometimes two to three years) to redeploy the cash. Furthermore you can actually hold your own proceeds, without needed a qualified intermediary.

When to Use a 1031 Exchange

But 1033 isn't always that simple. Sometimes there are some areas of gray. Perhaps you're voluntarily selling the property to the government agency and it's not really an involuntary taking, it's more of a negotiated voluntary sale that maybe would have resulted in the involuntary taking if the parties hadn’t come to a meeting of the minds.

In those situations where the potential taking never really amounted to an actual legal proceeding and it's more of a voluntary sale on your part - in those situations it's probably better to do a 1031 exchange.

However, if you actually have been served with a condemnation notice, this is a real legal proceeding, and it's not just the threat of condemnation it's an actual taking, in those situations you know you're clearly in the 1033 category.

1031 & 1033 Exchange Professionals

In either instance you can give us a call and we can help you understand the process and give you some pointers on what to do. For example, under 1033 it’s critical that you file an election on the tax return for the first year in which you receive any payments under that eminent domain taking.

• Start Your 1031 Exchange: If you have questions about section 1033, feel free to call me at 612-643-1031.

Defer the tax. Maximize your gain.

© 2017 Copyright Jeffrey R. Peterson All Rights Reserved

1031 Exchange Tips for Real Estate Closing Agents

If you work as a closer for real estate transactions and you're notified that one of the parties to the transaction wants to do a 1031 exchange, it’s important for you to make note of that right away in the file and find out who are the people that are helping facilitate this exchange. Here are a few tips for closing agents who encounter 1031 exchanges.

Eleventh Hour Fire Drills

We often get calls from closers at the eleventh hour saying that nobody made arrangements for the 1031 exchange. Everybody involved thought it was someone else's job to do, and now we need to hurry up and get 1031 documents prepared for a closing that's imminent. We can do that, but it's a real fire drill.

Questions to Ask

The better arrangement is to contact the party that intends to do a 1031. Ask them the following questions:

• Is this your relinquished property that you're selling?

• Have you started your process with a qualified intermediary?

How a Qualified Intermediary can Help

If they haven't started with a qualified intermediary, have them contact CPEC 1031 right away. We can get a copy of the purchase agreement and title work from you; we can gather the specific details in particular that we need from the seller; and we can put together the 1031 and the closing instructions that you'll need to know how to prepare the settlement statement and what notices need to be given to the other parties. This allows all of the documentation to be dealt with up front well before the closing occurs so that we have a smooth signing ceremony.

• Start Your Exchange: If you have questions about closing documents related to a 1031 exchange, feel free to call me at 612-643-1031.

Defer the tax. Maximize your gain.

© 2017 Copyright Jeffrey R. Peterson All Rights Reserved

Delaware Statutory Trust Ownership Structures

For people that are putting together real estate syndications, the old model that was often used for large-scale syndications was the tenancy-in-common model.

Tenancy-in-Common Model

With a tenancy-in-common model you'd have up to 35 co-owners of a property as tenants-in-common owning a property typically pursuant to a tenancy-in-common agreement. However when the recession occurred it became evident that the tenancy-in-common model wasn’t really doable because decision-making often had to be done by unanimous vote. It can be very hard to get unanimous agreement as to leasing a new tenant, or whether or not to refinance with a particular lender, or whether or not to sell the property.

Delaware Statutory Trust Model

These major decisions often caused log jams that made it very difficult for the owners of the property to work together. So a new model was created based in part on the old Illinois land trust. The new model is called a Delaware Statutory Trust. At the top of the ownership pyramid there is a figurehead owner - the trustee of the trust. But within the trust the beneficial owners are deemed to be the owners of the underlying real estate.

The beauty of it is that once the Delaware Statutory Trust is set up and it owns the property and it's got the property stabilized with the leasing in place, the financing in place, then ordinary investors can take their 1031 funds and invest them into the Delaware Statutory Trust where they receive a beneficial ownership interest in the trust. But for tax purposes they are deemed to own a fractional interest in the underlying real estate.

Institutional Financing

Furthermore the Delaware Statutory Trusts have set up institutional financing that the beneficial owners are not personally liable for. So they get the benefit of institutional debt without the personal liability. So if the property were to be foreclosed they likely would not have any personal liability for deficiency. For older investors that need to offset debt relief - debt that was discharged on their old relinquished property - they are comforted that they are able to defer their gains, take out new debt, but it's not debt that they’re personally liable for.

• Start Your 1031 Exchange: If you have questions about DST ownership structures, feel free to call me at 612-643-1031.

Defer the tax. Maximize your gain.

© 2017 Copyright Jeffrey R. Peterson All Rights Reserved

Maximum Leverage? Looking at Loan-to-Value Ratios by Property Type

Note: In this article, we hear from guest contributing blogger Kip Dunkelberger (kdunk@venturemortgage.com), the President and CEO of Venture Mortgage Corporation.  Kip leads this trusted, dynamic commercial real estate mortgage banking firm, and he himself is known as an experienced and resourceful problem solver in the realm of commercial real estate financing.  

Lenders evaluate commercial real estate largely based on the current and potential income generated by the property, the ease of finding replacement tenants (as applicable), and the degree to which the property is stabilized. With that in mind, let’s take a look at several property types and the general LTV ratios you can expect from potential lenders.

Remember that each piece of commercial real estate is a unique entity, and loan-to-value ratios can vary for a number of reasons: the examples below are presented in good faith only as general guidelines.

Multifamily

Multifamily properties have the distinct advantage of having tenants that are relatively easy to replace in the grand scheme of things. A single-tenant industrial building has a very limited, specific market of potential tenants, making it a riskier proposal in the eyes of a lender than a stabilized apartment building with thousands of potential tenants within a 5 mile radius on any given day. Therefore, owners of multifamily commercial real estate enjoy some of the highest LTV ratios in the market, and can push this ratio up to 85% in some cases, though 75 to 80% is more common.

Specialty/Recreational Properties

The income potential for these properties is largely seasonal and can be volatile, which can cause some lenders to be reluctant to lend on this type of commercial real estate at all. That is not to say all hope is lost: there are several lenders who are familiar and comfortable lending on these properties, and a commercial mortgage banker is a good option to assist borrowers in assessing the lay of the land in sourcing capital for these loans. However, because of the potential swings in income and the risk of drastic changes in the operating stability of these properties, borrowers should expect to see a cap of 50% LTV. Some very stable assets with a long history of good operation (and the documents to support such a history) could possibly push the LTV higher, perhaps to 55 or 60%, but that is relatively rare.

Borrowers should also be aware that valuation of these properties tends to be quite conservative, which could further reduce the potential loan size.

Retail (Strip/Center)

The retail sector of commercial real estate has seen some challenges in the past decade, but remains in relatively high esteem in the eyes of most lenders. It should be noted that retail centers are valued more highly (and have the corresponding higher LTV potential) if they contain one or more national, stable tenants (i.e., Walgreens, AutoZone, Caribou Coffee, Toys R Us, and the like) who will increase customer traffic for the lesser-known tenants and are unlikely to abruptly vacate or go out of business. Lenders also like to see leases with many years remaining for each tenant at the time of origination, which assures them that a property that is currently operating well will not lose half its tenants shortly after closing, and the higher the occupancy rate, the better. A stable retail strip center with low vacancy and good tenants can expect about a 70% LTV ratio, with very well-performing properties able to reach closer to 75% LTV.

Triple Net Leased National Single Tenant Retail

Perhaps the holy grail of leases, the true NNN or triple net lease obligates the tenant to be responsible for taxes, insurance, maintenance, capital expenses, and any other operating expenses associated with a subject property. The owner, in essence, only collects rent and pays the debt service to the lender. When combined with a long lease and a national, publicly traded company as the tenant (Wal-Mart, Best Buy, Aldi, Nordstrom, etc.), lenders are quite comfortable with LTVs up to 85% for these properties; in some cases, special loan programs offer the opportunity for a 90% LTV if the tenant has an especially good credit rating.

Here, we’ve looked a just a few of the many property types in commercial real estate and the range of loan-to-value ratios for each. We’ve explored the reasoning behind the LTV spectrum from the lender’s perspective, and we’ve advised that seeking a consultation with an experienced commercial mortgage banker can provide you with advice regarding the best lender for your property type, situation, and objectives. When it comes to commercial real estate financing, remember that tenants and cash flow are keys to a stabilized, well-performing property that makes lenders comfortable with a potential investment and allow borrowers to maximize their leverage. 

If you have questions about obtaining a mortgage or financing for a reverse exchange or any other commercial real estate investment, you are invited to call Kip Dunkelberger at (952) 843-5125, or email him at kdunk@venturemortgage.com.

Find Venture Mortgage online:

www.venturemortgage.com

Giving Written Notice in Your Purchase Agreement

In a 1031 exchange, typically the purchase agreements for the sale of the relinquished property or the purchase of the new replacement property are assigned to the intermediary by the taxpayer that's doing the exchange.

Old English Common Law

Under the Old English common law, an assignment was not considered effective until all of the parties to the contract were given written notice of the assignment. The IRS has adopted this Old English concept and in the context of a 1031 exchange when the seller of a relinquished property assigns their rights in the relinquished property purchase agreement to their intermediary, that necessitates the seller giving notice to the buyer of the relinquished property as well as any assignee, or parties that were assigned rights in that contract.

Well sometimes that's easy to do and sometimes it's hard to do because the buyer that's actually purchasing the property may or may not be affiliated with the original contracting party and it's sometimes difficult to track down all of the parties to the contract and give them written notice.

Replacement Property

The same thing goes on the replacement property. When you contract with the seller of the replacement property and then assign your rights in that purchase agreement to the intermediary, you must give written notice to that seller. There is often less rigmarole and assignments of the replacement property purchase agreement but nevertheless, if there are any other parties in that purchase agreement the treasury regulations require that the taxpayer give those other parties written notice of the assignment to the intermediary.

Making it Happen

So how do you make sure that you get that written notice proved up? You ask those other parties to sign an acknowledgement that they received written notice. How do you make sure that these other parties do that and give you the written proof? You make it a contractual requirement in your purchase agreements that ALL of the other parties will cooperate and will provide you with that requisite acknowledgment at or prior to closing.

For a sample 1031 cooperation clause, check out this link.

• Start Your 1031 Exchange: If you have questions about 1031 purchase agreements and cooperation clauses, feel free to call me at 612-643-1031.

Defer the tax. Maximize your gain.

© 2016 Copyright Jeffrey R. Peterson All Rights Reserved